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A great business makes a profit and generates cash from those profits. It accumulates cash over time and can do so without much in the way of debt. It makes regular investments in R&D. Such a business pays its expenses and taxes and perhaps makes distributions to stockholders along the way. In doing these things the great business makes its owners wealthy.
Managers in a large enterprise like a public company spend some of their time thinking about the business in terms of the numbers found in the company financial statements. They think and talk about profit margins, ratios, cash accumulation, return on equity and a variety of other facts about the business that are found in, or derived from, a profit and loss statement, a balance sheet and a statement of cash flow. Managers plan, evaluate performance, set goals and forecast using these numbers. Managers, in many small businesses, on the other hand, do not use these numbers for the purposes stated above and, in some cases, they do not use them at all. Small business owners are usually not trained in the use of these numbers and are not generally familiar with them. Entrepreneurial types are usually powerless when it comes to reading, understanding, analyzing and interpreting financial information.
You don't have to be an accountant to make good use of financial statements and the information they provide. Those who are willing to spend a little time with this information will find it empowering and rewarding. Those who develop some command over this information can create more profit, generate more cash and accumulate more wealth. In the final analysis that's what a business is supposed to do. In part, it's why you went into business in the first place.
Most of the small business owners I have known had a pretty straight forward financial plan. They didn't diversify to reduce risk. They put all of their eggs in one basket and bet the farm that they would succeed in business and become wealthy. If they succeeded, all of their financial problems were solved and their financial goals were accomplished. If they didn't succeed things got pretty bleak. But from one generation to the next, enterprising entrepreneurs and small business operators choose this route, in spite of the risks, because the rewards are so great. But to succeed you need all the help you can get. One of the things that can improve your chances for success, help you succeed faster and end up with more wealth is to acquire some command over the numbers. Running your business by the numbers (financial statement numbers) gives you another set of management tools that can make you a better manager and a more successful operator.
In his best seller, Good to Great, Tim Collins tells us how great businesses discovered a key metric that became a fundamental driver in helping that business go from good to great. How much more successful could you be if you knew the key metric in your business?
These articles that will appear on MindSpring every week or so will provide you with some insight into financial statement information that can make you a better manager and a more successful operator. These articles will systematically go through financial statements line by line, introduce you to ratios, key metrics and other data that can empower you.
The title of this first article, "Profit - Cash - Wealth," is a formula for wealth creation.
Obviously, to stay in business, you have to make a profit. You ultimately want to turn larger and larger portions of profit into cash and accumulate more and more cash over time. Cash, particularly large amounts of it, is a real manifestation of wealth. Certainly your business itself is a valuable asset and a manifestation of wealth. But businesses, of all sizes, are always vulnerable. In the end, cash is king.